One of the major setbacks that real estate investors encounter presents in the form of financing. The process of applying for a traditional loan involves a lot of hoops and this could result in losing out on a potential opportunity, especially since the market waits for no one. So, fast and readily available cash is a major requirement, and this is one of the primary benefits of hard money loans.
What is a Hard Money Loan?
A hard money loan otherwise known as a bridge loan would typically be offered by a non-traditional or private lender and allow investors to avoid the extended process and extensive requirements of traditional loans.
In essence, lacking in areas such as having an excellent credit score, credit history, and consistent income among other typical requirements may not be deal-breakers for a hard money loan.
Instead, a hard money lender is primarily concerned with the value of the property being used as collateral. This is because, in the event that the borrower is unable to meet the agreed terms, the lender would sell the property to recoup the funds released.
This loan type is usually for a short-term (typically 12 to 36 months, or at Fund That Flip, 6 to 12 or 6 to 18 months), is non-conforming, and is mainly used by investors for real estate transactions. Their characteristic feature of a short funding time frame is one of the reasons why investors opt for this loan type.
In addition, the asset-based lending nature of the loan, as well provision of access to construction capital while eliminating restrictive consumer underwriting and project oversight are among other leading reasons why real estate investors opt for hard money loans relative to traditional bank loans.
Benefits/Pros of Hard Money Loans
In the right situation, hard money loans are an excellent financial choice, and can also be a bailout option when you are in a tight spot. Here are some major benefits of opting for a hard money loan:
Traditional loans have a slew of requirements including a good credit score, good debt-to-income ratio, decent credit history, recent W-2, and many others.
On the other hand, hard money loans may provide real estate investors who have a bad, fair, or little credit history with an avenue to skip all of those and get right to the capital to fund their project. Usually, most reputable lenders may consider creditworthiness alongside property value, however, the requirement is not mandated as it is with traditional loans.
Once the property is vetted and found to check the hard money lender’s boxes, you may be well on your way to securing that loan.
Ease of Access to Funds
One of the major impediments to real estate transactions is the long wait for funds disbursal, particularly if you are using a mortgage. This has not in any way been helped by the implemented mortgage lending regulations found in the Dodd-Frank Act.
This implies that waiting for a loan could run into months, leading investors to lose out on potential real estate goldmines. Opting for a hard money loan could see funding provided within a few weeks.
Furthermore, running out of funds when working on a project that has a set timeline for completion could imply a whole lot of trouble. In such a scenario, a hard money loan could allow you to meet your target thanks to easy and rapid access to funds.
Unlike traditional loans that have requirements mostly set in stone and provide little or no wiggle room, hard money loans allow more freedom. Since they are offered by private lenders, you might be able to negotiate the terms of the loan.
Since each deal is individualized and doesn’t follow a uniform underwriting process, you may be able to:
- Negotiate a repayment schedule to fit with your plans
- Eliminate or cut down certain fees such as the origination fee
- Negotiate interest rate (this is easier if you have a good track record with the lender).
Choice of Collateral
Usually, the lender considers the investment property to be collateral for the loan. However, some lenders could provide a measure of freedom with respect to the choice of collateral.
For instance, personal assets such as your residential property or a retirement account could be put up to get the loan. You should note that this is not the case with all lenders.
Downsides/Cons of Hard Money Loans
Hard money loans may come with some major perks, but they also feature some downsides you’ll have to come to terms with. Here are some of the major cons of opting for a hard money loan:
Possibility of Losing Collateral
If you default on the loan and breach the terms of the agreement, the lender is within full rights to repossess the property. This would typically be sold to cover the funds disbursed. However, you can easily avoid this by having a foolproof plan and following the loan agreement: Make payments on time and within the stipulated loan duration, and you can avoid repossession altogether.
High Interest Rates
Hard money loans involve a significant measure of risk on the part of the lender, and this is typically reflected in the interest rates or the cost of the capital. Based on the terms of your loan, lenders may charge interest rates ranging from 8% to even 10% or more.
Requirements for Hard Money Loans
The requirements for hard money loans may differ from lender to lender, however, here are the basics that cut across board:
- Required down payment for property to be used as loan collateral (usually 30% to 40% for commercial properties and 10% to 30% for residential properties) or sufficient equity
- Origination fee/points (1% to 5% of the total loan amount)
- Underwriting fees (range from $500 to $5000)
- Closing costs
There might be certain other requirements that would be detailed by your lender.
What Can You Do With Hard Money Loans?
The class of individuals who take the most advantage of hard money loans are real estate investors. They generally use the funds for one or more of the following:
- Renovating and renting
- Transactional funding
- Property flipping
- New construction
Renovating and Renting
Some investors specialize in purchasing, renovating, and then renting out the projects. In this case, a longer refinance term might be necessary upon project completion to ensure that maximum value is gotten for the property.
Also known as wholesale funding, hard money loans are a go-to here because of their rapid funding process. Also, neither the seller nor the buyer need to be privy to your financial spread and is a solid alternative to using contract assignments.
Property flippers commonly take out hard money loans to fund projects while said project also serves as collateral. However, lenders may have certain specific requirements.
For instance, a direct, hard money lender like Fund That Flip requires that the house flippers be experienced, so, in the event that a house flipper is looking to use hard money, they would need to have flipped a minimum of five houses.
Financing new construction of a real estate project can also be done using a hard money loan. The funds cover the cost of materials and workmanship, as outlined by the loan-to-cost in your agreement so you are able to complete construction seamlessly.
The benefits of hard money lending significantly outweigh the downside — particularly if you have a plan in place. It is a great way to rapidly access funds and exploit excellent investment opportunities. Overall, be sure to weigh your options so that you can make an informed decision that will work for you.
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